Page 347 - Microsoft Word - 00 ACCA F9 IWB prelims 2017.docx

Capital structure

Question 1

Operating gearing

Two firms have the following cost structures:

Bat Co Man Co
$m $m
Sales 10.0 10.0
Variable costs (2.0) (4.0)
Fixed costs (4.0) (2.0)
–––– ––––
EBIT 4.0 4.0
–––– ––––
Calculate the operating gearing for each company (as fixed costs / total costs)
and determine the impact on each of a 10% increase and of a 10% decrease in
sales
Fixed/total costs 67% 33%

10% increase in sales
Bat Co Man Co
$m $m
Sales 11.0 11.0
Variable costs (2.2) (4.4)
Fixed costs (4.0) (2.0)
–––– ––––
EBIT 4.8 4.6
–––– ––––
EBIT % change +20% +15%

10% decrease in sales
Bat Co Man Co
$m $m
Sales 9.0 9.0
Variable costs (1.8) (3.6)
Fixed costs (4.0) (2.0)
–––– ––––
EBIT 3.2 3.4
–––– ––––
EBIT % change –20% –15%
The higher the operating gearing, the higher the volatility (risk) of profits

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